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Almost one year on from Prada’s Hong Kong IPO debut, the ensuing volatility of its share price and, ultimately, the company’s surging profitability, what are the lessons for luxury goods companies with an eye on a stock market listing?
Prada, the Italian luxury fashion house famous for making trendsetting handbags and footwear, raised US$2.14 billion from a Hong Kong IPO in June last year. That was around a fifth less capital than the company had planned for. As things transpired, retail investors were put off by the prospect of Italian capital gains and dividend taxes, which they were liable to pay (even though the listing was in Hong Kong).
If early results were disappointing, fast-forward almost a year and Prada has much more to cheer about. The company reported organic growth of 23% for 2011, which surpassed expectations, while profit surged 72%, the company’s best ever performance. Click to tweet! Crucially, the share price today is some 25% higher than at the time of the listing, trading at 23 times forward earnings.
The listing has been a bumpy ride, though. Firstly, Prada had to revise down its share price range prior to the IPO, and ended up getting priced at the bottom end of that revision. Secondly, the share price shot up in July but then proceeded to lose around a third of its value to December, as investors panicked about stock market and real estate declines. This year to date, Prada’s stock has gained around 40%, three times more than the benchmark Hang Seng Index.
Prada needed to raise capital, first and foremost to fast track its expansion ambitions into China and other emerging markets. The New York Stock Exchange, the biggest in the world by market capitalisation, was arguably a safer choice. But, the upside of Hong Kong – with its savvy luxury goods investor base and its position as a corridor into the booming consumer story of China – was a bigger growth opportunity.
That the share price has been so volatile is a measure of the risk in instigating an IPO in relatively uncharted waters. Indeed, risk is a core reason why other luxury goods companies, with an eye on a Hong Kong listing, have hesitated. Prada was bold in its listing strategy, and that has to be one of the biggest lessons. It is one thing to identify emerging Asia – and China in particular – as the sweet spot of luxury goods opportunity, it is another to act on it.
The UK’s Graff Diamonds has chosen Hong Kong over other bourses too, and could do even better than Prada, given the growing investment appeal of ‘hard’ luxury goods such as diamonds and timepieces that are heavily insulated from negative macroeconomic pressures. Growth in demand for diamonds is running at around 6% globally, twice as high as the available supply of stones, and China is driving the curve. The gap between supply and demand could get wider this year (and into 2013), which will push prices up.
What is clear is that without the capital raised from an IPO, Prada would not be able to capitalise so quickly on new retail real estate opportunities. That has been a lynchpin of its growth strategy, with 75 new store openings in 2011, eight of which were in China. That retail model will consolidate going forward, with 160 directly owned stores planned over the next two years, bringing the total number in Prada’s global network to 548.
Prada has moved speedily away from a wholesale model, which was shown to have fundamental weaknesses in the aftermath of the 2008 financial crisis – most damagingly when third party outlets ramped up discount activity to generate sales. Prada’s own store retail network fuelled 78% of net revenues in 2011, and that share will increase to over 80% this year, with the emerging markets the big drivers. Taking control over distribution is, therefore, another key lesson from the Prada growth model.
In 2012, emerging Asia (mostly China), Brazil, Morocco and the Middle East will collectively absorb half of Prada’s new stores, according to company sources. Given the proposed outlet growth surge, there is perhaps a risk that Prada might dilute some of its luxury credentials. After all, luxury as a concept derives from its rarity, not from its ubiquity.
That scenario is unlikely. Firstly, Prada is being smart in its segmentation strategy – developing affordable luxury products as well as high end and, as such, catering to different consumer groups. Secondly, Prada now has direct control over the majority of the route to market, including the pricing, and it tends to be heavily discounted prices for luxury goods that can most damage brand equity.
The rumoured roll-out of a new discount (albeit designer label) brand of stores for China is not necessarily a threat to brand heritage, though. This shows that Prada is adaptable, and not afraid to adjust its brand heritage to maximise opportunity. It is not without risk, but the potential of a wider consumer base is hugely attractive. And this segmentation model has worked well for Armani, with Armani Exchange.
In China, it is about staying ahead of the competition, and tailoring the business model to an eclectic consumer base. In the luxury cars market, for example, Lamborghini is planning to make an SUV, which is some way from its comfort zone. It is a direct commercial response to Chinese preference trends. For similar reasons, Bentley is also planning its own foray into SUVs for China. The lesson, from the car manufacturers and from Prada, is that China is too important to ignore what its consumers are asking for.
We are not yet a full year into Prada’s Hong Kong listing, and there will be myriad new challenges going forward. China’s economy is cooling, for example. There are also concerns among some investors that rising real estate prices and erratic stock markets could erode demand for luxury goods.
There is no sign of that happening yet. In 2011, China was Prada’s biggest growth market, with like-for-like sales up 40%. And Euromonitor International forecasts that China’s luxury goods spending will increase around 8% a year to 2015 (at constant prices).
Although China is clearly pivotal to Prada’s recent growth surge, the developed markets have played their role too. Sales last year were up 16% in Japan, 17% in Europe and 20% in the US, for example, and almost half the store openings in 2011 were in Western Europe.
It is true that Chinese, Brazilian, Russian and other emerging market visitors were responsible for a big share of growth in these developed markets. But, Prada has not allowed itself to become over-reliant on the BRICs. Rather, it has used its Asian listing to build a stronger position in emerging Asia, and the capital raised has also been a springboard to building a more global brand. As a result, Prada is better placed to spread risk today than it was before the listing. This is arguably the most important lesson.